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Why a Global Wealth Tax Reduces Inequality

The distribution of incomes and assets is one of the most controversial themes today. History teaches us that economic forces press in different directions - either to more equality or away from equality. Which will prevail depends on what political decisions we make.
WHY A GLOBAL WEALTH TAX REDUCES INEQUALITY


By Thomas Piketty


[This article published on July 3, 2014 is translated from the German on the Internet,  http://blog.arbeit-wirtschaft.at. The French economist's 650-page book "Capital in the 21st Century" has been a No.1 bestseller in the US.]


The distribution of incomes and assets is one of the most controversial themes today. History teaches us that economic forces press in different directions - either to more equality or away from equality. Which will prevail depends on what political decisions we make.


The US is an illustrative example. The US was understood as the antithesis to the patrimonial societies of old Europe. Alexis de Tocqueville, a historian in the 19th century, saw the US as a place where land and property were so abundant that houses were affordable to everyone and a democracy could develop. Up to the First World War, the concentration of assets in the hands of the rich in the US was less extreme than in Europe. In the 20th century, this situation was reversed.


INSTITUTIONS AND TAXES CAN PREVENT GROWING INEQUALITY


Between 1914 and 1945, asset inequalities in Europe were practically wiped out through war, inflation, nationalization and taxation. Afterwards European countries built institutions that are more structurally egalitarian and inclusive than those in the US - despite all their weaknesses.


Ironically many of these institutions were inspired by the US. From the 1930s to the early 1980s, Great Britain maintained a balanced income distribution through high taxes on obscenely high incomes. This very progressive income tax was really a very American invention - arising in the inter-war period, a time when the US resolved to avoid the extreme inequalities of European class societies. This American experiment with high taxes did not harm economic growth. Economic growth was higher at that time than since the 1980s. This idea deserves to be revived - in that country where it first prevailed.


The US was also the first country where across the board debts for everyone arose and nearly complete literacy was achieved - at least among white men. Europe needed almost 100 years for that achievement. However Europe is now much more inclusive. Many of the best worldwide universities are found in the US although Europe successfully created more respectable medium-level universities. According to the Shanghai ranking, 53 of the best 100 universities are in the US and 31 in Europe. Still 202 of the best 500 universities are in Europe while 150 are in the US.


CHANCES OF EQUAL OPPORTUNITIES ARE RHETORIC


Whether in France, the US or elsewhere - the rhetoric of equal opportunities rarely has anything to do with the facts. Its goal is often the justification of existing inequalities. Access to US universities - once one of the most open in the world - is very unequal. Creating university systems that really unite efficiency and equal opportunities is one of the greatest challenges facing all countries.


Mass education is important but does not guarantee the fair distribution of incomes and assets. Income inequality in the US has become more critical since the 1980s and reflects above all the enormous incomes at the top. Why is that? Did the skills of managers develop so much stronger than all others? In a large organization, it is generally hard to say how valuable the work of every individual person is. Nevertheless high incomes imply top managers on the whole have the power to determine their own salaries. This thesis is empirically well proven.


HIGH CAPITAL PROFITS IS AN IMPORTANT FACTOR FOR WEALTH INEQUALITY


If the inequality in work incomes can be brought under control, another factor from history often strengthens little inequalities until they reach extreme levels. That is the case when asset profits for owners of capital accumulate faster than the economy grows. The share of capitalists in the total income rises even more at the expense of the middle and lower classes. The inequality in the 19th century was worse because asset profits surpassed economic growth. These conditions will probably be repeated in the 21st century. According to Forbes' global billionaire ranking, top assets grew three times as fast between 1987 and 2013 than the world economy. The following table shows the general trend of the growth of wealth and incomes for different groups.







Table: Average annual growth rate of assets/ incomes for different groups of the world population

Group Average annual growth rate 1987-2013 (%)

Assets of the richest hundred millionth 6.8

Assets of the richest twenty millionth 6.4

Worldwide GDP 3.3

Worldwide average assets per adult 2.1

Worldwide average income per adult 1.4


Source: Capital in the 21st Century


WEALTH TAX AS GROWTH BRAKE FOR MAMMOTH ASSETS


The inequality in the US may now be so massive and political processes so captured by the top earners that this will not happen - as in Europe before the First World War. But that should not keep us from striving for improvements. The ideal solution would be a global progressive tax on individual net assets. Those just starting out would pay little while those who own billions would pay much. That would keep inequality under control and enable climbing the ladder to the top. It would put the global dynamics of asset development under the control of the public. The lack of financial transparency and reliable wealth statistics is one of the greatest challenges for modern democracies.


Obviously there are alternatives. China and Russia must also deal with wealthy oligarchs with their own means: with capital controls - and prisons whose bleak walls restrain the most ambitious oligarchs. A worldwide wealth tax is the better way for countries that prefer the rule of law and an international economic system. Perhaps China will even be convinced by us. Inflation is another potential solution. In the past, inflation helped relieve the burden of public debts. But inflation also reduces the savings of the less well-to-do. Thus a tax on mammoth assets seems more sensible.


A worldwide wealth tax would need international cooperation. This is hard but feasible. The US and Europe are responsible for a quarter of worldwide economic output. If they would speak with one voice, a global claim on financial assets would be within range. Sanctions could be imposed on tax havens that refuse cooperation. If this does not happen, many could turn against globalization. When they find a common voice one day, the forgotten mantra of nationalism and economic isolation will be recited.
[This article was originally published on the LSE British Politics and Policy Blog.]


WORK AND CAPITAL WITH PIKETTY


By Hagen Kramer


[This article published on July 18, 2014 is translated from the German on the Internet,  http://blog-arbeit-wirtschaft.at]


What determines income distribution in the long term? For neoclassical theory dominant today, the economic laws are crucial against which social groups anxious for distribution cannot prevail. Power factors play practically no role in conventional analysis although always present in wage negotiations. This is hardly different in the bestseller "Capital in the 21st Century" by Thomas Piketty. In his models, functional income distribution is defined "technically", as Piketty writes in several passages. The influence of power on distribution is not considered.


A hundred years ago the Austrian economist Eugen von Bohm-Bawerk in an essay with the same title raised the question about the determination of income distribution: "Power or Economic Law?" He lay the foundations for the neoclassical answer that economic laws solely determined income distribution in the long run. Since the French economist Thomas Piketty's analysis and prognosis are often judged radical and innovative, I ask myself how the Bohm-Bawerk question is answered in the bestseller "Capital in the 21st Century."


DOES PIKETTY GIVE REASONS FOR THE INCOME DISTRIBUTION?


When Piketty's explanatory model of fixing wages and profits in the aggregate economy is analyzed more closely, he seems to argue very conventionally. His model of growth and distribution is based on the current assumption of a neoclassical production function. In such a model, the functional income distribution is determined exclusively "technically."


The situation on the labor market has a decisive influence on the negotiating position of the parties to wage agreements - not only in the short-term. This is hard to deny. The negotiating power in wrestling over the wage level depends on the situation on the labor market. To my amazement, the factor unemployment does not play any role with Piketty! There isn't even an entry in the keyword index of his 650-page book.


This is a central contradiction that in my opinion is out of place in Piketty's otherwise convincing argumentation. For me, Piketty's great merit is that he shows that some of the sty8lized facts that marked the standard models of growth and aggregate economic income distribution for decades are not true any more. He demonstrates this on the basis of admirable empirical studies. The capital-coefficient is not constant in the long-term nor the profit rate as Nicholas Kaldor assumed in an influential argument in the 1960s. Piketty undergirds this with solid data. The reality-based models cannot be ignored in the future.


WORK AND WAGE INCOME COME OFF WORST


For Piketty, the analysis of capital and capital incomes is at the center, not work or labor. In his book as in many earlier studies, he intensively discusses the incomes of top managers and shows that the marginal productivity theory cannot be applied in fixing manager compensations. For determining wages in general, he has no problem starting from the authority of a neoclassical production function. However this approach is only acceptable when full employment situations are analyzed since the production function is based on the idea of the efficient use of resources.


Full employment has been the exception, not the rule for a long while in the reality of market economies. The negotiating power between capital and labor has to be influenced by permanent unemployment. A glance at development in Austria illustrates this connection. The highest labor-income rates are found (with a certain time-lag) in the times of full employment of the 1960s and 1970s. The labor-income rate fell again and again with the rise of the unemployment rate in the middle of the 1970s and particularly since the beginning of the 19809s. Developments in other OECD countries look very similar. The question could be raised why the brilliant empiricist Piketty completely fades out this factor from the analysis of income distribution. [The labor-income rate is conceptually similar to the corrected wage rate in Austria.]


Piketty's relation to the neoclassical macro-economic distribution theory is also dubious for theoretical reasons. In the framework of the theoretical controversy over capital of the 1960s, the different capital goods cannot be aggregated to a single reality "capital" outside of a one-sector model. The great US economist Paul A. Samuelson admitted this at the end to critics of the theory of neoclassical production and capital from Cambridge (England). However Piketty's presentation of the Cambridge-Cambridge controversy completely passes by the core of this argument. He was way off the mark when he said in his book that he supposedly tackled the question about the constancy of capital-coefficients. Obviously he is not very familiar with this problematic.


SHIFTS OF INCOME DISTRIBUTION SHOULD BE EXPLAINED AND NOT ONLY MEASURED


With his book and his research projects, Piketty helped move distribution questions into the focus of the public and economic research. This is absolutely necessary. On the other hand, a convincing theoretical model explanation for analyzing income distribution is lacking. The process of concentration of incomes and assets continually advanced in the past. We can assume this development will continue for different reasons. But the explanations offered us by Piketty are inadequate. [This article was originally published on the Herdertrieb (herd instinct) blog.]

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